Writing employee paychecks is a major responsibility. Payroll is often the biggest expense that a company incurs and needs to be done efficiently and without errors. Beside the effects on profits, there’s also various tax liability factors as well as retirement plans, medical plans and retirement plans to consider. Payroll has an affect on many aspects of the business including profitability and employee welfare.
Mandatory and Voluntary Payroll Withholding Deductions
Mandatory payroll withholding are generally those that are mandated by various government agencies. Some of the more common mandatory deductions include:
- Federal income tax
- State income
- Local taxes
- Social Security
- Medicare
- Court mandated withholding
Voluntary deductions are generally authorized by the employee and can vary depending on the company’s policies. Some voluntary deductions may include:
- Medical insurance
- Retirement plans (401K)
- Company stock purchases
- Union dues
- Charity
- Payroll draws and company purchases
Federal and State Withholding Payroll Taxes
Every employee needs to have a Federal Form W4 filled out and signed. This form serves as the basic guidelines for the amount of taxes withheld from the employee’s paycheck. The form is generally used for both federal and state personal income tax withholding. A new W4 should be filled out at the beginning of each calendar year.
Once the W4 is completed, the payroll clerk needs to calculate the amount to be deducted by using the appropriate federal and state tax-withholding table. In most cases the amount deducted depends on the employee’s martial status and the amount of dependents. Employees can also withhold an additional dollar amount or a percentage of gross pay. Make sure the table used is for the correct pay frequency, weekly, bi-weekly, bi-monthly or monthly.
Social Security and Medicare FICA Withholding Payroll Taxes
Social Security taxes are withheld and deducted from an employee’s paycheck at a specific percentage. The percentage for 2010 is 6.2%. The employer is also responsible to pay an additional 6.2%, so the actual amount that must be paid in Social Security tax is collectively 12.4%. The employee pays 6.2% and the employer pays and additional 6.2%.
Social Security tax also has a cap for each calendar year. The cap for 2010 is $106,800. Once the gross pay reaches $106,800, the deductions stop until the start of the next calendar year. As an example, if an employee has a gross pay of $140,000 at the end of the year, $33,200 is not subject to Social Security tax ($140,000 -$106,800).
Medicare tax is withheld at a rate of 1.45% for 2010. Just like the Social Security tax, the employer must match the Medicare tax paid the employee, for a total of 2.90%. Unlike the Social Security tax, there is no cap on Medicare. Social Security tax and Medicare collectively is known as the Federal Insurance Contribution Act or FICA.
Journal Entries for Payroll and Financial Statement Impact
Journal entry transactions for payroll affect both the income statement and balance sheet. From the income statement, the actual expense of employee payments along with other withholdings and tax payments have a negative affect on net profit. From the balance sheet, assets are decreased for cash payment and liabilities increased for taxes and other deductions.
Below is a sample of common journal entries for payroll. For this example we’ll use a weekly payroll expense of $5,000
- Salary Expense - $5,000 Debit
- Federal Income Tax Withheld Payable - $617.50 Credit
- State Income Tax Withheld Payable - $200.00 Credit
- FICA Tax Payable - $382.50 Credit
- Retirement Account Payable - $200.00 Credit
- Medical Insurance Expense - $300.00 Credit
- Red Cross Payable - $100.00 Credit
- Payroll Payable - $3,200 Credit
Note in the above example that all entries are an increase to expense (debit) and payables (credit) except medical insurance expense. The actual amount withheld for medical expense decreases the company’s medical expense by the amount withheld.
Once the above journal transactions are completed, the payroll payable amount is then paid to the individual employees. The end result would be a credit to cash of $3,200 (decrease) and a debit to payroll payable of $3,200 (decrease).
This article basically gives simplistic instructions on manual payroll procedures. Most companies either use a computerized payroll or a payroll service to streamline the procedure. Even though the vast majority of companies use some type of automated system, it’s still important to have a basic understanding of payroll procedures to maximize profitability and asset utilization.
James Clausen - Clausen received a Bachelors Degree in Business Administration in Automotive Management and Marketing at Northwood University, graduating ...
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